Credit card companies relish in a dirty business, giving millions of people very small credit lines with incredibly high interest. To further the spending addiction, credit card companies make it extremely easy – and often rewarding – to use the card at as many places as possible. In addition to the revenues they earn on both merchant charges and interest, credit card companies hold a dirty little profit secret: extra fees. In fact, these fees often reward companies with more money than a full year of interest payments.
However, the profit party may be over for credit card companies. American legislators are now proposing changes that will alter the playing field that credit card companies have dominated for decades.
A Dramatic Business Change
Besides interest rate caps and changes in the maximum interest rate, credit card issuers face a huge change to their current business model. At present, most credit card companies apply monthly payments to the lowest interest balance first – which ensures that the balances take longer for the consumer to pay off, while the companies get to pocket higher profits from larger interest rate charges. While consumers hope that consolidating their credit cards will help them lower their interest costs, this is not always the case in reality. Democrats are hanging out this dirty credit card laundry to dry and hoping to make legislative changes to alleviate the issue – but this is a bridge credit card issuers are willing to die on, and these changes may not be included in the final bill. However, gauging the response from the House and its vote, this bill will likely make it through the democratically controlled Senate.
Who's Affected the Most?
The most affected companies are those that issue “sub-prime” credit cards that flood consumers' mailboxes. These companies often charge high interest rates and even higher default interest rates and extra fees for each missed or late payment. The result is that these companies can charge fees as high as $39 for a late payment, even if the balance was just $10. That's an effective interest rate of 400% in one month, which terrible for anyone trying to get out of their small debt.
Capital One vs. American Express
Capital One does excellent business in serving credit cards to borrowers with poor credit. In contrast, American Express is good at giving cards to people who can pay them back. Their business models reflect the spectrum of business philosophies, with American Express' cards carrying lower APR and higher limits that allow more business and luxury use. By doing so, American Express can also target its market, offering retail establishments access to its users by paying a premium price for credit card use. In contrast, Capital One gives very small credit lines to many people and at higher interest rates. With this strategy, Capital One can produce higher profits, albeit with more customers.
Premium Issuers to be Least Affected
Premium issuers will be least affected because they draw more profits from less customers and also rely less on late fees and other fee schedules to draw profits. Looking forward, American Express makes a lot more sense as an investment than Capital One or other low end lenders.
What the Legislation Means for Their Stocks
The new legislation is sure to put a dent in the bottom line of many credit card companies. Unable to draw additional profits from consumers, they'll either have to raise their interest rates across the board, or live with reduced profits. The changes may be minute or dramatic; however, if any industry can easily defray a new cost, it will be credit card companies. After all, they're very good at what they do.